LEGAL ARTICLE

FOR A BETTER UNDERSTANDING

Regulation 45-106 of the Quebec Securities Act

An important change in corporate law affecting more than 99% of the companies in Quebec

Recent changes to the Quebec Securities Act have important consequences for the legal status of the majority of companies operating in Quebec. The notion of « private company » has been abolished. These changes affect all companies and corporations, even those with a sole shareholder.

In the past, all that was required to become a « private company » was to insert three clauses in the articles of incorporation.

A « private company » would then be entitled to an exemption to certain cumbersome and expensive procedures provided by the Quebec Securities Act, in particular, the obligation of prospectus and registration.

This general exemption no longer exists. Regulation 45-106, adopted under the authority of the Quebec Securities Act, now provides an exemption for « private issuers ».

The notion of « private company » has been replaced by that of a « private issuer ». Corporations having gained the status of « private issuer » will be entitled to an exemption of the obligation of prospectus and registration similar to that of the former « private company ».

However, with the new provisions of the Quebec Securities Act and its Regulation 45-106 a corporation must now obtain the status of « private issuer » as well as maintain that status by ensuring that every issuance of shares or titles of the corporation are done in accordance with the requirements of the Quebec Securities Act.

What is a « private issuer »?

« Private issuer » means an issuer that is not a reporting issuer or an investment fund

whose securities, other than non-convertible debt securities

are subject to restrictions on transfer that are contained in the issuer's constating documents or security holders' agreements

are beneficially owned, directly or indirectly, by not more than 50 persons

that has distributed securities only to persons specified in Regulation 45-106

A corporation that has distributed securities only to persons described in section 2.4 of Regulation 45-106

Companies incorporated before the changes to the Quebec Securities Act have until October 12 2007 to comply with its new provisions and attain the status of « private issuer ».

Once a corporation has the status of « private issuer » the issuance and transfer of securities does not require any administrative formality provided that the transaction is conducted with a person that acts on his own behalf and falls within the other categories stated in the Regulation.

A company that does not qualify as a « private issuer » can issue shares by either following the obligations of prospectus and registration or availing itself of one of the other stated exemptions available.

However, a company that takes advantage of another exemption must file a Report of exempt distribution on or before the 10th day after the distribution and pay the mandatory fees of 0.025% of securities issued and sold in Quebec with a minimum of $250.00.

A company's failure to file the report is committing a penal offence which can result in a fine of $1 000 up to $50 000 for the company. Employees and directors that allow the offence are also subject to the same sanctions.

A company that does not qualify as a « private issuer » will have to follow these formalities with every new issuance of securities.

A company which issue shares under circumstances where an exemption is unavailable and without respecting the obligation of registration and prospectus, commits an infraction which can lead to severe fines of $5 000 to $5 000 000 for the company as well as for its directors!

With the new requirements of Regulation 45-106, a corporation can lose its status of « private issuer » if it issues securities to persons not listed in its provisions. This requirement is retroactive for all issuances of securities since the company's inception.

Categories of people admissible as purchasers of securities of a « private issuer ».

A person who purchases the security as principal and is:

a director, officer, employee, founder or control person of the issuer

a spouse, parent, grandparent, brother, sister or child of a director, executive officer, founder or control person of the issuer

a parent, grandparent, brother, sister or child of the spouse of a director, executive officer, founder or control person of the issuer

a close personal friend of a director, executive officer, founder or control person of the issuer

a close business associate of a director, executive officer, founder or control person of the issuer

a spouse, parent, grandparent, brother, sister or child of the selling security holder or of the selling security holder's spouse

a security holder of the issuer

an accredited investor

a person of which a majority of the voting securities are beneficially owned by, or a majority of the directors are, persons described in paragraphs a to h of Regulation 45-106

a trust or estate of which all of the beneficiaries or a majority of the trustees or executors are persons described in paragraphs a to h

a person that is not the public

Thereafter a corporation will have to avail itself of other exemptions which require the filing of the Report of exempt distribution as well as payment of mandatory fees or follow the obligations of registration and prospectus.

Transfers or resale of securities of a company qualifying as a « private issuer » are also subject to exemptions. It is the responsibility and obligation of the seller to know and respect these exemptions.

The default to adhere to the provisions of the law can lead to penal sanctions ranging from $1 000 to $20 000 for an individual and $1 000 to $50 000 for a corporate entity.

The resale or transfer of securities without prospectus and without an available exemption can lead to a fine of $5 000 to $5 000 000 as well as imprisonment for up to 5 years!

Amongst other things, corporations will have to amend their articles of incorporation in order to comply with the new regulations.

Failure to proceed with these modifications could result in additional procedures and much higher expenses whenever there is a transfer or issuance of shares. Failure to respect the new regulations can result in penal sanctions ranging from hefty fines to imprisonment in certain cases.

A corporation previously considered a « private company » will not automatically gain the status of « private issuer ». It is therefore essential to verify the status of every corporation to avoid serious surprises that could prove costly not only to corporations but its shareholders as well.

Failure to conform to the new provisions of the Quebec Securities Act and its regulations can have serious repercussions for your clients. For example:

A client that wishes to transfer shares to his children ( even a single share for one dollar ), will have to ensure that this is done in accordance with the new regulations if he does not want to incur expenses to issue or transfer the shares.

A transfer of shares that does not comply with the new regulations may possibly be declared null and void and be annulled.

The sale of a corporation could become more difficult. Not qualifying as a « private issuer » could decrease the value of the shares in the eyes of a buyer not wanting to be subject to procedures of the Quebec Securities Act regarding the issuance and transfer of shares.

A legal adviser could recommend to his client not to buy the shares of a company if he is unable to carry out a thorough verification regarding the conformity of a company to the new provisions of the law. Your clients could therefore lose the potential capital gain exemption for the sale of their shares.